In the past year, I have started contributing monthly to a private pension fund since there is no scheme offered by my employer. I received the end-of-year summary of the fund and it is less than the sum of what I have contributed in the past year. This is obviously due to the turbulent economic environment that is likely to continue this year and potentially beyond.
My question is, should I stop contributing to my fund until there is some more stability back in the economy? I understand that markets fluctuate like this over a lifetime of pension contributions, but since I’ve started my contributions, it’s already worth less than if I had just left it in my bank account.
I am 29, so I still have many years ahead to contribute to retirement. My financial adviser who helped me set up the fund has recommended that I keep contributing and not look at my fund summary, but they also have a financial incentive to keep me investing so I’m not sure if that recommendation is totally unbiased.
Would my money be better placed saving up and putting down for a mortgage instead of putting in a retirement fund?
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Ms EG
I suppose the first question is: are they? Are markets really falling?
If you look at the stock markets, they all seemed to have hit the low in their current cycle last September or October. If you look at the fairly broad-based FTSE 250, it is up 20 per cent since that point.
So despite the ongoing economic uncertainty with surging inflations, rising interest rates and widespread fears of recession, markets have recovered some of their poise. That’s not to say there might not be further setbacks. The latest assessment is that recession, where it happens, will be shorter-term and less dramatic than had been feared in developed countries. Markets might still wobble but they are resilient.
On the plus side, your fund has presumably been investing your contributions into stocks at a temporarily cheaper end of the cycle, which should let you lock in more benefit as the market picks up.
How you have fared to date depends on when you started investing. The FTSE 250 is still down about 10 per cent on the level it would have been trading at the end of January last year. But you could look at it another way and say you were lucky you did not start your pension investment back when the index hit its peak in summer 2021, in which case you’d still be 17 per cent down.
And if you’re rattled by your recent experience, be glad you did not start your pension at the end of 2019 only to see the FTSE 250 plunge 31 per cent in the first quarter of 2020 as Covid-19 struck.
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None of which is to dismiss the all-too-human nerves at how our money is performing. We work hard for the money we earn and it is natural to be somewhat sceptical and even nervous when our end-year investment statement shows that it is worth less than the amount we put into it. But you cannot look at pension savings in the short term.
No one would sensibly suggest that you never keep a watchful eye on your savings. Circumstances change that can require adjustment to strategy. But most financial advisers will, like yours, suggest you are better not keeping too close an eye on short-term performance. They’re correct.
Perhaps tune in after five years and see how things are going and again at 10 years, but not every month or even every year. As you have found, if you are in the wrong part of a cycle, short-term performance can be grim. Investing is not a straight line game; there will be ups and downs.
Clearly, you are correct that advisers can have a financial incentive to keep you invested but they are fairly heavily regulated so are necessarily careful in what they say to clients. In my view, in this case, the adviser is absolutely correct.
When you are young, a pension will be more heavily invested in stock market shares. There is good reason for this. To provide the retirement savings you are hoping for, your investment needs to deliver strong returns and those are most often found in the stock market.
Yes, that does require taking a certain amount of risk but the reason pension investments are skewed towards stock markets in your early working years is that you have time to recover from any market setbacks. Over the longer period, stock markets do deliver, even if individual stocks may not.
To some degree, you are playing with free money. You get tax relief at the highest rate you pay income tax on your contributions to your pension. If the money was not going into a pension, you would be paying up to 40 per cent tax on it
For instance, going back to our FTSE 250 index performance, if you look how it has done over the past 20 years, you can see that its value is now five times what it was back in February 2003. That intervening period has included some generational shocks – the financial crash and Covid-19 – that have led to dramatic shorter-term setbacks in the index but over the longer term it is still paying off for investors.
And it is not just the FTSE 250. The same pattern broadly is true for the FTSE 100, the Dow or the broader US Standard & Poor’s 500. The S&P500 is up just short of fivefold over the past 20 years, and if you go back further to the sort of timespan of an average worker’s pension – 30 or 40 years – it is up more than ninefold and 28-fold respectively.
You’ll hear a lot about lifestyling in pensions investment. That means the bigger risks are taken when you are young to build up a pension pot and these risks are reduced as you get older and come closer to retirement because you will not have the time to recover losses if they occur at that stage.
The other thing to remember when assessing performance is that, to some degree, you are playing with free money. You get tax relief at the highest rate you pay income tax on your contributions to your pension. If the money was not going into a pension, you would be paying up to 40 per cent tax on it.
For most people, they are also getting money into their schemes from their employer – often matching their own contributions – and again this is money they would be surrendering by stopping their pension saving. I’m conscious this does not apply to you at the moment in your current job, which is a bit miserable of your employer but it will probably be a factor as you move through your working life.
Under auto-enrolment, which is due to be introduced in Ireland next year, your company would be forced to match your payments up to certain limits. Initially, it would be 1.5 per cent of your gross salary, rising to 3 per cent four years after the new system comes in, 4.5 per cent after six years and 6 per cent from year 10.
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Tax relief will work slightly differently under auto-enrolment. The State will pay €1 for every €3 you invest, so up to 0.5 per cent of your gross salary at the outset, rising to 2 per cent of salary from year 10.
That will mean that 3.5 per cent of your salary will be invested in a pension scheme for you for a 1.5 per cent contribution by you at the outset, rising to a 14 per cent of salary investment from year 10 for the 6 per cent that it will cost you – once you take account of the mandatory employer’s contributions and the tax relief.
Ultimately, only you can determine how best to juggle your financial commitments. If you are saving for a mortgage, or a new baby has arrived, it may be that money that would otherwise go into a pension fund will have to be diverted elsewhere for a while. There are only so many ways to slice your financial cake.
But early investment in a pension is one of the most critical factors in determining your financial wellbeing in retirement so try to keep putting at least something – even a reduced amount – into that pot. And if you are reducing contributions, make sure it is for the other sort of financial commitments mentioned above, not just to leave it sitting in your bank account.
Countless different bits of research tell the same story: even the savviest of investors cannot precisely “time the market” so that they invest just as markets are taking off and take their money out of the game just as they are about to dip. And those who try tend to see their investment pots fare worse over time than people who simply left their money in the market.
Please send your queries to Dominic Coyle, Q&A, The Irish Times, 24-28 Tara Street Dublin 2, or by email to dominic.coyle@irishtimes.com. This column is a reader service and is not intended to replace professional advice
